Amerigroup Tries to Regroup

"We believe the cost trend and other problems at Amerigroup and Molina (which has suffered its own shortfall) are mostly company-specific driven by overly aggressive expansion within the Medicaid sub-sector of managed care," explains Goldman Sachs analyst Matthew Borsch, who has a neutral rating on the managed-care group overall. "Beyond the specific expansion strategies at those two companies, we also highlight that the reimbursement and utilization dynamics within Medicaid are quite different from commercial or Medicare, and that we have no signs of more widespread signs of an uptick in cost trends or industrywide reserving issues."

Prudential analyst David Shove tends to agree.

Shove believes that the Medicaid-only business model suffers from unique flaws. Notably, he says, the Medicaid-only insurers have come under pressure from states to build vast provider networks that make effective cost controls quite difficult. Moreover, he says, those same states dictate reimbursement levels and therefore leave the Medicaid companies highly vulnerable to any unexpected spikes in medical costs.

In contrast, Shove says, commercial managed care companies seek tight control over both provider networks and pricing and -- not surprisingly -- lose their bids for some state contracts as a result.

Bear Stearns analyst John Rex echoes that theme. He believes the Medicaid players now carry some of the same risks that fast-growing commercial insurers once did.

"The Medicaid group has been a growth story ... with the market very focused on enrollment -- and the stocks at one point garnering a very significant premium," writes Rex, who has an overweight rating on the managed care sector in general. "Issues of predictability and actuarial precision remind us of the (then new) commercial sector in the mid-1990s and highlight the risks of some of the less-developed players."

Since then, of course, traditional managed care players have moved on and enjoyed quite a run. Thus, Rex suggests sticking with the biggest of those -- specifically Aetna (AET Quote), UnitedHealth (UNH Quote) and WellPoint (WLP Quote) -- going forward. He has no rating on the Medicaid-only players at all.

Meanwhile, Borsch recommends both Aetna and Health Net (HNT Quote). He believes that managed care stocks, in general, should keep rising through at least the first half of next year. After that, however, he sees potential challenges. For example, he worries about smaller benefits from mergers and Medicare opportunities going forward. And he still believes a cyclical downturn will come.

However, he concludes, "our view is that the next commercial underwriting cycle downturn -- while inevitable -- will likely not set in until 2007 or later."

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